Tax Tricks: Time to Go on Offense

Our current tax system rewards unproductive speculation and punishes the working middle class.

For three decades, progressives have been engaged in a political contest where the range of the playing field runs between our own goal line and our own 20-yard line. During the period that we have been fighting over some version of the Bush-Reagan tax cuts, the other side has focused on wiping out the labor movement, locking in regressive monetary policy, pushing a trade and currency policy explicitly designed to redistribute income upward, creating a system of intellectual-property protection that serves the same purpose, and using huge deficits to wipe out public spending.

We have to continue fighting for progressive taxation, but that is no cure for the rest of the conservative agenda. If we become obsessed with tax breaks for the rich and ignore everything else, the skewing of before-tax income will become so large that even the most redistributive taxes will still leave gross inequities. Furthermore, since money puts politicians in office, in a highly unequal society, politicians who support redistributive taxation will find it increasingly difficult to win elections. Therefore, if we don't focus on the larger policy issues affecting income distribution, we will inevitably lose the tax battle as well.

In addition to progressive taxation, we also need adequate levels of taxation to finance government, because it is public spending that helps sustain the working middle class. The right's successful strategy has been to starve government with regressive tax cuts, then to demand spending cuts.

The larger battle brings us on to very difficult terrain in large part because the other side has been so successful in setting the terms of the debate. For example, the Federal Reserve Board is absolutely central in determining the level of employment. While it cannot always bring unemployment down (as it is haplessly attempting now), the Fed certainly can ensure that unemployment stays up.

This is hugely important because high unemployment invariably worsens the income distribution and disproportionately hits those at the middle and bottom. Janitors and factory workers are far more likely to lose their jobs in a downturn than are doctors and lawyers. High unemployment also undermines bargaining power and puts downward pressure on the earnings of most wage and salary workers in the middle to bottom.

The right has been immensely successful at undermining all the other policy levers that affect the security of the working middle class. For example, the suggestion that the Federal Reserve should take more responsibility for maintaining high levels of employment, both now and more generally, is viewed as somehow injecting politics into monetary policy -- as if the current course were decided through an apolitical process.

Trade is also enormously important for income distribution, as is implied by economic theory and supported by recent research. In the last three decades, we have deliberately placed U.S. manufacturing workers in direct competition with low-paid workers in the developing world. The predicted result is a decline in the wages of U.S. manufacturing workers and, more generally, downward pressure on the wages of workers without college degrees, since manufacturing disproportionately employs non-college-educated workers. This effect is compounded by the decision to allow the dollar to remain overvalued, which makes goods produced in the United States even less competitive internationally.

Policies on intellectual property can also have the effect of redistributing income upward. Lately, courts and legislative changes have increased the power of holders of patents and copyrights, at the expense of innovators and consumers. These changes increase windfall gains -- economists call these "rents" -- and skew income to the very top. In a recent paper, the Organization for Economic Co-operation and Development found that by far, the largest single factor contributing to the growth of wage inequality over the last three decades was the amount of patent rents earned in a country. Remarkably, few progressives pay any attention at all to patent and copyright policy, despite the enormous sums at stake and the huge impact that such policy has on inequality.

The fact that progressives must look beyond the narrow range of tax and transfer policy does not mean that we should ignore tax policy, especially the upcoming battle over extending the Bush tax cuts to the wealthy beyond 2012. But we have to start being more creative in our approach.

For example, a financial speculation tax (FST) not only provides a great opportunity to raise a large amount of revenue (as much as $1.8 trillion over the next decade) through an overwhelmingly progressive tax; it also provides an opportunity to directly attack one of the main sources of growing inequality. Many of the most outlandish paychecks on Wall Street depend on the sort of quick-turnover trading that would become far less profitable with an FST. Implementing such a tax could have at least as much impact on the before-tax distribution of income as it does on the after-tax distribution.

Of course, getting an FST will not be simple. Opponents, including many top figures in the Democratic Party, will do everything in their power to prevent an FST from ever being taken seriously. But the battle for such a tax is well worth putting before the American public. On one side are the politicians who want to cut Social Security and Medicare to meet their deficit targets. On the other side are leaders who want to tax the Wall Street speculators who helped to crash the economy. There would be little doubt which side the public would favor if given a clear choice, even if the campaign contributions go heavily in the opposite direction.

The FST is unusual as a tax that will directly have positive distributional consequences. The larger agenda for restoring greater equality must include new approaches to monetary policy, trade policy, and patent policy as well as labor -- management relations and corporate governance, but taxing Wall Street speculation in order to protect our most important social welfare programs would be a great place to start.

We also have to be alert to the trend of using the tax code to provide social benefits. Often, the only way the right will support "spending" is to disguise it as a tax credit. While some tax credits, such as the Earned Income Tax Credit, are beneficial, others, such as the tax preferences used to subsidize affordable housing, are extremely inefficient because much of the cost goes to financial speculators rather than tenants. High on the right's agenda is the use of tax credits to replace Social Security and Medicare. In general, using the tax code to provide social benefits undercuts the public support for the affirmative use of government, because the benefits are not seen as government spending at all.

As we go to press, there seems to be an elite consensus for a new round of tax "reform" in which many tax preferences are reduced or eliminated and rates are cut. This is a shameless case of changing the subject, when topic A should be producing a robust economic recovery. This approach, favored by the Bowles-Simpson Commission and the business elite, and embraced by the Obama administration, will do nothing for either the recovery or the income distribution. On balance, it will leave the rich paying a lower share of the tax load. We need to keep focused on restoring middle-class jobs and earnings and reject policies -- tax or otherwise -- that deflect attention from that goal.